When a borrower has been making regular and timely payments toward their mortgage as outlined in the terms of their loan, the associated note is considered to be in good standing and is classified as a performing note.
Performing notes are commonly owned by institutional investors – banks, mortgage companies, or investment firms – or they may be held by an individual who is providing seller-backed financing to a borrower.
Their status as a performing note is fully backed by evidence of timely payments, usually in the form of canceled checks and bank statements.
Performing notes are a popular investment option. Often sold at a moderate discount from the perceived real value of the physical property that they’re attached to, performing notes can offer a long-term, collateral-backed investment, that is unaffected by the day-to-day volatility of the stock market.
Performing notes enjoy limited sensitivity to fluctuations in interest rates. Best of all, with a solid history of timely repayment, they can provide fixed monthly income through the principal and interest payments remitted by the borrower.
Even if a performing note is paid off by the borrower, typically through a refinance or sale of the home, an investor will still realize income from the “collateral gap” – the difference between the discounted price they paid for the note and its actual value.
Performing notes offer relative ease of management. Unlike owners of rental property who often have to deal with the hassle of maintenance or tenant issues, note investing is largely paper-based, which also makes it feasible to invest in multiple notes without adding much in the way of additional work.
Finally, note investing offers versatility in terms of realizing a return on investment. Note holders can buy and sell partials – arrangements with other investors to buy or sell part of the payment term of a note – and use the revenue to purchase additional similar investments. They can also borrow against the value of the note, or sell the note to another investor.
As with any investment, performing notes do come with some amount of risk.
There is the possibility that a borrower who has been in good standing will encounter financial difficulty at some point during the term of the loan and miss a payment. In this situation, the noteholder will need to either work with the borrower to arrange a schedule to bring the payments up to date, modify the loan, or even initiate foreclosure proceedings in the event of a serious delinquency that can’t be resolved.
Another risk comes from a borrower who refinances the loan shortly after the investor purchases the associated note. Because part of the investment income is realized from the monthly interest payments, the shorter the time period that a noteholder owns the note, the lower the potential return on investment.
A note investor should conduct thorough due diligence on a note prior to purchase to mitigate as much risk as possible. They should examine prior payment history and creditworthiness of the borrower, understand the condition of the property, gain awareness of any issues with the underlying paperwork, verify appropriate insurance coverage, and assess whether the area in which the property is located is declining or growing.
Alvernia Capital Management purchases performing notes from both institutional investors and “mom and pop” sellers as part of our overall investment strategy.
Our experience with investing in performing notes and the ability to purchase a large number of notes allows us to mitigate the associated risk. We continually reinvest in notes as part of our goal to realize a return on investment that will be used toward our overall mission to stabilize affordable neighborhoods across the United States without displacing deserving residents.
If you’d like to know more about performing notes, click here to provide us with your contact information and we will contact you to talk further about this investment option.